All bull markets are alike. All bear markets are horrible in their own way. So it is with this one.
It’s been stunningly fast. But what gives it individuality is not so much its speed but its seeming simplicity: overpriced market hits terrifying virus.
The trigger for the crash may have been unpredictable, but it at least makes sense: there is no ocean of financial alphabet soup to wade through here. No CDOs (collateralized debt obligations) squared. But if the beginning was comprehensible, the end is not.
Analysts everywhere have models for economies and markets. They aren’t madly accurate. But they can offer clues about how things might work out – and at the very least they have agreed inputs. However, no models have inputs that include the superfast spread of viral pandemics through a global economy obsessed with freedom of movement.
So, we have a lot of unknowns. We don’t know much about the virus itself. We don’t know enough about how more governments will eventually react to it in terms of quarantine, or how we will react to their reactions. How long, for example, can you keep families cooped up in small flats in Rome without levels of compliance collapsing? Friends there say not much longer.
We also don’t know whether a new recession will give us a new Great Financial Crisis. We’ve all been asking important questions for a while. We may now find we didn’t really want to know the answers.
In a U.S. recession, what happens when record levels of corporate debt are downgraded to junk and funds have to sell it? Some 52 per cent of the investment-grade universe is already BB rated. And what of the overvalued unlisted firms held by all fashionable asset management companies? So much leverage. Such high odds of collapsing cash flows.
This didn’t start as a credit crisis, financial crisis, liquidity crisis or even political crisis. Yet, it could easily become all of those things.
With all this in mind, the thing we have no real sense of is how to value stocks in this environment.
For the past week, in the absence of any real information, it has been impossible to anchor valuations. If the global economy is to disappear while we all bicker at home, the downgrades to come are going to make every optimist’s eyes water – and the “earnings” part of every price/earnings ratio is surely immediately irrelevant.
If government bond yields are to be zero or below, the old-fashioned idea that you can value equities with reference to bond yields is silly. And if the future of policy involves helicopter money, central bank equity buying, endless “loans,” payment holidays and handouts to all (which it does), what is anything worth in absolute terms? Not easy is it?
But. But. But. The U.S. market falling 27 per cent in 16 days is a big deal. Stock markets are sometimes slow off the mark and then often hysterical.
But they are also wonderful discounting machines – and they are doing their job. Every dollar you spend today buys you more equity than it did last week. The U.S. still isn’t cheap – only its current dividend yield looks interesting on a 15-year basis, and even that doesn’t look much good on a 25-year basis. But most other markets are now trading below their historical averages on all measures.
In Britain, numbers from Duncan Lamont, head of research and analytics at Schroders PLC, which is good at value investing, put the 15-year median cyclically adjusted price/earnings ratio at 13, the price/book ratio at 1.8 times and our trailing price/earnings ratio at 14 times. Today, those numbers are 11, 1.8 and 10.
Finally, the dividend yield on the MSCI index of large-cap stocks in Britain hit 6.6 per cent this week. Assume you will never see another dividend from the energy sector, says Mr. Lamont, and that comes down to 5.5 per cent. The historical average is 3.8 per cent.
You can argue that these numbers are useless in an environment as confusing as this one – that’s fair. But bear markets are usually characterized by investors arguing themselves out of buying. That’s why we always miss the bottom. Note that the future was not exactly set in stone in 2008, yet the yield in Britain topped out at 6 per cent.
Add to these interesting valuations the collapse in the oil price. While almost all recessions are kicked off by high oil prices (possibly including that of 2008), not once in the past 50 years have we had a recession begin when the value of the global oil market was below its average relative to global gross domestic product, as it is now, says James Ferguson, founding partner at Macrostrategy.
Cheap oil can’t stop a recession this time given the twin demand and supply shocks created by the virus. But remember why it usually does: this kind of fall acts like a US$1-trillion odd tax cut for consumers.
Other support is on the way from governments. We’ve seen some monetary bazookas so far, but it will be the fiscal stimulus that should eventually make the difference. Governments that have destroyed incomes (how does a cash economy such as Italy’s survive isolation?) have a duty to replace them.
A decade ago, we would have called what we are about to see bonkers. This year we are going to call it innovative. Hello helicopter money. I can’t pretend to approve of all this long term – but in the short term, I am pretty sure markets will.
I am not suggesting you pile in full tilt right now. To be sure that the market is close to bottoming out we need to see a little more certainty – news on a vaccine, clear evidence of global containment, the inevitable full fiscal frontal, or even just a sense that we can learn to live with a world of extremely clean hands.
But while you wait for these things, keep an eye on what is long-term cheap (valuations are only good as a long-term measure of “likely”), watch market movements and begin to drip feed money into those things. For example, should Britain’s banks or real estate investment trusts really be on yields of 9 to 10 per cent?
For retail investors, it’s often an awful lot easier to buy value slowly on the way to the bottom than to try and chase markets back up.
Merryn Somerset Webb is editor-in-chief of MoneyWeek. Views are personal.
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